As the Holidays Near, Have Some Fun with Gifting

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Craig W. Smalley, EA
Founder/CEO
CWSEAPA LLP
Columnist
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I woke up this morning and there was a slight chill in the air. Living in central Florida, our version of cold compared with northerners is completely different. However, after a miserable, muggy summer in Florida, we relish our “chilly days.”

My wife grew up in Chicago, so every December, when the temperatures in Florida are in the 80s, she will tell me “it doesn’t feel like Christmas.” I was raised in Florida, and every single Christmas was in the upper 70s or low 80s.

To appease my wife, the last few years on Christmas Day I’ve taken her and the children on short, three- or four-day getaways to see the snow. The reason the trip is so short is because I don’t do well with temperatures lower than 40 degrees, much less snow and ice. 

Last year’s trip found us in Chicago. On the day after Christmas, we were walking around downtown and it started sleeting. I had never seen sleet before, but I decided quickly that I hated it. I made the lovely discovery in the bracing wind chill of -10 degrees that sleet was just frozen rain. 

The Windy City rudely showed me why it earned that title. Not only was I bundled in two layers of clothing, a snow jacket complete with a hood, and a scarf that covered most of my head, but I was being pelted by this sleet in the face. The wind took each icy piece of sleet and cruelly introduced it to the portion of my face that was uncovered. I mean, obviously, it would find the exposed part. Each piece that met my skin felt like tiny puncturing needles. We would walk the streets until the pain was too much for me and then duck behind a building to shelter us from the sleet’s assault on my virgin southern skin. 

“Never again,” I told my wife, as she giggled at me.

The weather got me thinking about my wife’s version of Christmas, which led me to presents, which led me to the gift tax, which led me to writing this article. So, let’s discuss some neat things we can do with gifting.

First of all, you can give $14,000 to any one person without having to file a gift tax return. If you are married and you and your spouse elect to “split” your gifts, you can give $14,000 to one person and your spouse can give $14,000 to the same person, for a total of $28,000. Each year around this time, I meet with my wealthy, older clients and give this advice.

The reason behind that is to move assets out of their taxable estate. By gifting to children, children’s spouses, grandchildren, and their spouses, they can move quite a bit of money around without the threat of having to file a gift tax return. 

Last year, I met with a client who had a different situation. He was 75 years old and his total assets amounted to $12 million. His wife had died the year before and they benefited from the estate tax portability. However, his particular situation could be applied to anyone.

He owned about $4 million in Disney stock. His grandchildren were entering college and were no longer dependents of their parents. He wanted them to focus on their education, not work, like he had done when he put himself through school. My client told me that he had to give them more than the normal $14,000 this year and was willing to file the gift tax return. I didn’t want the amount of the gifts to chip away at my client’s estate tax exemption, so I devised a strategy that he loved.

He decided to gift his three grandchildren $5,000 of Disney stock and $9,000 in cash. To remember the rules of gifting, the child picks up the basis of the stock, as it was in the transferor’s hands. The stock was sold for $14,000. The children did not have any earned income. What was the taxable effect to the grandkids? Nothing. Nada. The big fat goose egg.

Why? Very simply, the grandchildren were 18 years old and not claimed as dependents. If they were younger than 18 or older than 18 and claimed as dependents, then the “kiddie tax” could be an issue. However, none of that applied.

When the children sold the stock, they had a gain of $9,000 ($14,000 - $5,000). The grandchildren were in the 10 percent tax bracket and didn’t have any capital gains tax. My client had successfully transferred $23,000 to one person without having to file a gift tax return.

Using the same strategy a few years earlier, I met with a client who wanted to gift his son his business. The parents were subject to the estate tax and wanted to remove their largest asset – their business – from their taxable estate. The family business had been around since 1970. The father’s basis in the stock was $1,000. The company was worth $25 million and was an S corporation (could this get any harder?). 

The father wanted to stop working and travel the world, but he still wanted to receive distributions from the company. He needed a creative way to remove the company from the estate, maintain control of the business, and have all the rights to current income. I know what you are thinking, and it wasn’t easy, but you didn’t see my bill, nor his elation to pay it.

The first obstacle we had was how does the father get rid of his stock in the corporation but maintain control? Remember, this is an S corporation, so we can only have one class of stock. There were 1,000 shares that were issued and another 6,500 shares in reserve. The company’s yearly net income was approximately $3 million. The father wanted to get $150,000 a month from the corporation. So, we made 5 percent of the outstanding stock “voting stock” and the remaining 95 percent “nonvoting stock,” thus preserving the one-class-of-stock rule, but having the father maintain control of the company.

The father kept the voting shares and transferred the nonvoting shares to an intentionally defective grantor trust (IDGT), whose beneficiary was the son. We had to refile the S-election under the QSub rules because a grantor trust was now the owner of 80 percent of the corporation. We sold the 80 percent of the nonvoting shares to the IDGT for $20 million, which was encumbered by a 20-year note to the father at the applicable federal interest rate at the time.

You are probably thinking “well, the father must pay capital gains tax on the sale,” and you would be right. However, he is paying it under an installment sale, and the taxable amount was around $1 million a year, taxed at 20 percent capital gains rate, or $200,000 a year. That sounds like a lot, but it was a tax savings of $150,000 that he would have paid if the amount was ordinary income. Upon death of the father, the rights to the note went to his wife, and then upon her death, the payments were made to five separate Section 529 plans, for the benefit of the five grandchildren. Did you see that? We also skirted generation-skipping tax.

It is a little confusing, but they wanted the most tax-advantageous way to skirt the estate and income tax, have control over the business until death, pay the least amount of tax on the sale of the business, and pay for all five grandchildren’s college tuition at the same time.

Like I said, fun with gifting.

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Nov 28th 2016 16:52

Nice article, Craig. I'm curious about your handling of the Disney stock matter. It appears that the man would have been required to file a gift tax return? I'm not an expert on gift tax, but I believe it is the market vale, not original cost basis, that determines the value of gifts. So the gift, for gift tax purposes, would have been $23,000 ($9k cash and $14k stock at FMV).

I believe you are correct, that for income tax/capital gain purposes, the donors basis is used, so a $9k capital gain resulted.

Please correct me if I am wrong in this, as gift tax is not my strong suit.

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to skinnyvinny
Jan 30th 2017 13:05

It's his basis that he picks up the stock for gift tax purposes

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